Audit Committee, 07 Nov 2006

Meeting date: Tuesday, November 7, 2006

Official Report 240KB pdf

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Section 22 Reports

We are pleased to have a briefing from the Auditor General on the section 22 reports that he has made on the 2005-06 accounts of Argyll and Clyde NHS Board, Lanarkshire NHS Board, Western Isles NHS Board and Highland NHS Board.

There are section 22 reports on four national health service board accounts for 2005-06. The reasons for the reports vary.

As the committee is well aware, Argyll and Clyde NHS Board was dissolved on 31 March 2006 and responsibility for its services was transferred to Greater Glasgow and Clyde NHS Board and Highland NHS Board. The auditor's report highlights that Argyll and Clyde's cumulative deficit of £81.7 million was cleared by an enhanced provision within the board's final revenue resource limit from the Scottish Executive Health Department. The RRL is the amount of money allocated to a board to spend on its day-to-day operations in any one financial year. There were several legacy issues for the two successor boards, including the £28.4 million of underlying recurrent deficit that was inherited from Argyll and Clyde.

The Health Department has set three financial targets for NHS bodies, one of which is that they must not exceed their revenue resource limit. For 2005-06, auditors reported that two health boards failed to meet that target, one of which was Lanarkshire NHS Board. In the case of both NHS Lanarkshire and NHS Western Isles, the auditor's opinion highlights those failures, although the opinion is not qualified.

In 2005-06, NHS Lanarkshire recorded a net response outturn of £731.691 million against an RRL of £723.298 million. That is an overspend against the RRL of £8.393 million, which is 1.16 per cent of its total RRL. The board made an in-year surplus of £11.6 million in 2005-06, but the overspending against its RRL was due to a deficit of £20.042 million brought forward from previous years. The board has a financial recovery plan in place and it aims to eliminate its underlying recurrent deficit and achieve recurrent financial break-even by the end of 2007-08. I have reported on this issue in previous years and this is the third year in which there has been a section 22 report on NHS Lanarkshire's accounts.

As I mentioned, the second board that failed to meet its RRL target is Western Isles NHS Board, which had an in-year deficit of £1.746 million in 2005-06, and a brought-forward deficit of £0.738 million for 2004-05. That board therefore has a cumulative deficit of £2.484 million in 2005-06. In absolute terms, that sum of money might not be seen as significant by members of the committee, but it represents more than 4 per cent of its total RRL of £57.331 million. The board has a financial recovery plan in place and it aims to break even by 2008-09. However, the auditor has identified risks that could affect the successful delivery of this plan, such as the fact that the board needs to make significant reductions in its locum costs.

I prepared a section 22 report on the NHS Western Isles accounts last year. As well as highlighting the board's failure to meet its RRL target, last year's section 22 report drew attention to the auditor's concerns about the board's governance arrangements. In its final report on the 2005-06 accounts, the auditor reports that the board has taken action to address weaknesses in its internal control but that more work is needed to improve its risk management arrangements. This year's section 22 report on NHS Western Isles also draws attention to the interim management team that the Health Department has brought in to support the new interim chair.

Finally, I will deal with NHS Highland. The auditor has qualified its true and fair opinion over the accounting treatment of two private finance initiative contracts. The auditor and the board have a difference of opinion over the accounting treatment of the PFI contracts for the mental health facility at New Craigs and the primary care resource centre in Easter Ross. I will outline the issues, but I emphasise that they are essentially technical accounting matters. If the committee would like to ask questions about them, I am pleased that Russell Frith is here to assist me in providing any answers.

The first difference of view relates to a technical issue about the accounting treatment of the total finance charges that relate to the lease of the mental health facility PFI at New Craigs. The board has accounted for that contract as a finance lease since the facility opened in July 2000 but, in the auditor's view, the board has incorrectly apportioned the interest charges. Recent changes in auditing standards and the increasing cumulative effect of the error mean that in the past year the matter has become a material issue, which has led the auditor to qualify NHS Highland's accounts. That results in an undercharge to the operating cost statement of approximately £426,000 for the current year and an accumulated undercharge for the period up to 31 March 2006 of £2.6 million.

The second issue at NHS Highland relates to the accounting treatment of the primary care resource centre in Easter Ross—members will recall that I prepared a section 22 report on that last year. The board's view is that the transaction should be accounted for as an operating lease on the basis that substantially all the risks and rewards of ownership reside with the PFI contractor, which takes it off the balance sheet. However, the auditor's view is that, given the lack of evidence from the board to support its view, and in the interest of transparency of public finances, the transaction should be accounted for as a finance lease and should be on the balance sheet.

NHS Highland has discussed the matter with the Health Department but has been unable to provide further evidence to the auditor to support its view, so the auditor's qualified opinion continues in 2005-06. The auditor reports that, had the board treated the centre in Easter Ross as a finance lease, it would have increased its fixed assets by £8.7 million and long-term liabilities by £1.067 million. Depreciation would have increased and finance charges would have increased by £944,000. That would have resulted in a net additional charge of £150,000 in NHS Highland's operating cost statement.

That is a brief outline of the four reports. As ever, I am happy to answer questions with my colleagues' assistance.

Other health boards have PFI contracts. Do they do what you suggest rather than what NHS Highland does?

The situation has occurred only in NHS Highland.

I will follow that up, although I have a question about another health board. Will you explain what the changes to the figures mean? Could they cause problems with the organisation's ability to fund other developments?

The sums of money are comparatively small, but they are increasing, so we have reached the point at which it is appropriate for the auditor to comment. Russell Frith will help with a fuller explanation.

The question in relation to the mental health facility at New Craigs was about accounting for interest differently. A possible parallel is with a domestic repayment mortgage. In the absence of interest rate changes, the borrower makes a fixed cash payment each month for the duration of the mortgage. However, the mortgage lender accounts for that differently at different stages of the mortgage. Whereas in the early months of the mortgage most of the payment is recognised as interest and very little of it as capital, in the latter stages most of it is recognised as capital and very little of it as interest.

Highland NHS Board has been taking the fixed monthly payment and dividing it between interest and capital in the same proportion every month throughout the length of the lease. It should have recognised more interest and only a small capital element in the early part of the lease. If it had done that, interest payments later in the lease would have been much lower. The total amount of interest paid over the term of the lease remains the same. The issue is simply about the timing of recognition of that interest. Under the accounting standard, the board should have recognised more interest in the first five years of the lease—in fact, until about halfway through the lease. That way, it would have got lower interest charges in its accounts during the later part of the lease.

The consequence of that is that the undercharge to the operating cost statement amounts to about £426,000 this year and the accumulated undercharge up until the end of March 2006 is £2.6 million. The auditor felt obliged to comment because that is a significant sum.

That was helpful.

I want to pick up on the response that the Auditor General gave to Robin Harper. He said that Highland NHS Board is the only board that uses the accounting practice in question. Did other boards account in that way until they changed their methods to take account of the updated view of how such payments should be recorded?

I am unaware of the detailed negotiations that may have taken place between individual health boards and the auditors about that, but I cannot recall any equivalent issues arising.

There were some fairly robust discussions between auditors and health boards when projects first came through, but as far as I can remember none of them resulted in a final disagreement between the auditor and the health board.

If guidance was provided by the Health Department, is Highland NHS Board out of sync with that guidance?

All boards are obliged to apply current accounting standards. We have a situation in which the auditor is supported by the experts in Audit Scotland in the firm view that accounting standards are not being properly applied by NHS Highland. To that extent, guidance would not help a great deal. The position is clear.

The extent to which PFI projects should be treated as being off balance sheet is a grey area. The Treasury provides the United Kingdom guidance on the issue and it is consulting all the national audit agencies to reconsider that grey area, which in the past has tended to result in what appear to have been different treatments in different parts of the UK for broadly similar projects. A lot of work is being done on that at UK level.

That aside, and taking into consideration the answers that you have given to members' questions, can we anticipate that the way in which Highland NHS Board treats PFI projects will change or should we anticipate a further section 22 report next year because its treatment of such projects has not changed?

As you know, I am always unwilling to speculate. Given the present situation, if there is no change in the Treasury guidance on accounting standards or in the board's view of the matter, there is a good prospect that a further section 22 report will be produced next year.

On the first issue that the convener mentioned, our understanding is that Highland NHS Board now accepts that the timing of the recognition of interest on finance leases is an issue and it is considering whether to change its position. My estimate is that the position will change for the next set of accounts.

On the issue of PFI balance sheet treatment, as there will be a change of auditor this year, one of the incoming auditor's first priorities will be to review that project in some detail.

Of course, members will discuss our reaction to the section 22 reports in private at the end of today's meeting. Therefore, we do not need to decide at this stage how to treat all this information.

If there are no more questions on the report on Highland NHS Board, we will move on to the other reports.

I am not sure whether the Auditor General will be able to provide any more information on this issue. The report on the former Argyll and Clyde NHS Board mentions that, given the board's considerable underlying deficit of £28.4 million, the successor boards will need to develop cost-saving programmes to address that. Is there any indication as to whether there have been positive moves forward on that issue?

Both Greater Glasgow and Clyde NHS Board and Highland NHS Board are doing a lot of work to manage the situation. As might be imagined, the auditors are keeping the matter under fairly close scrutiny and are keeping closely in touch with the situation. Further information on the situation will be available in our financial overview of the NHS in Scotland, which we intend to publish in December. I anticipate that the audit for the current financial year—2006-07—for both health boards will include quite a full account of how the successor boards have managed that deficit.

I had intended to ask a question only on the section 22 report on Lanarkshire NHS Board, but the Auditor General's answer has prompted me to ask another one about the report on NHS Argyll and Clyde. Do we have details on how that figure was broken down between the two successor boards?

A significant amount of work was done by both boards to come to some agreement about where the underlying deficit should sit. I think that the agreement was that the bulk, if not all, of the deficit will sit with Greater Glasgow and Clyde NHS Board. That is the position as know it at the moment but, as the Auditor General said, the auditors are keeping a close eye on the issue and we are keeping in touch with the auditors about what that means for both boards.

Clearly, that is a significant issue, but we will come back to it.

Do members have any more questions on the report on NHS Argyll and Clyde?

When we considered a previous section 22 report on NHS Argyll and Clyde, a lot of work was being undertaken by the auditor, the board officers and the department. Did the situation then stabilise or did it get worse than the accounts show?

When the committee took evidence on Argyll and Clyde NHS Board, a lot of information was given about the clinical plan which, it was suggested, would make many savings when it was introduced. With the dissolution of the board and the absorption of the services into the two successor boards, that plan has been put on hold. Therefore, the two successor boards will need to consider not only the financial issues but the clinical configuration of services within the former NHS Argyll and Clyde area.

Would it be true to say, then, that the underlying deficits are being carried until that process is completed?

I cannot remember the date that the Health Department has given by which the boards need to break even, but they are looking at how they can recover that position.

As there are no more questions on Argyll and Clyde NHS Board, are there any questions on the report on Lanarkshire NHS Board?

The section 22 report identifies that Lanarkshire NHS Board has a cumulative deficit of £8.393 million. In the board's plan for dealing with the deficit, was that position expected at this stage or did it think that the deficit might have been worked out by now? I note in the submission that the sale of Law hospital will contribute to removing the deficit and it is clear that Lanarkshire NHS Board thinks that the sale will clear the deficit by 2007-08. Will that remove any risk of deficit in the following year or will the board be in the same position because that one-off payment from the sale of the hospital will remove the deficit for only one year?

The board is in a slightly better position than expected in 2005-06 because it made an in-year surplus and thereby reduced its deficit. The board expects to sell Law hospital in 2006-07, but the sale is still subject to planning permission, which introduces a slight element of uncertainty. That sale will clear the deficit, but the board has given itself another year to break even.

As there are no further questions about Lanarkshire NHS Board, we move to questions about Western Isles NHS Board.

Further to the Auditor General's point about locum costs contributing to the deficit, is there any correlation between the deficit and the consultant contract, which the committee considered previously?

I doubt whether we have an exact figure for that. The auditor highlighted cost pressures in relation to locums, which are a significant issue; the final costs of agenda for change; and the impact of national tariffs. We are aware that there were significant costs for the board in relation to the consultant contract and that it had great difficulty in filling vacancies, but I am not sure that we have that level of detail about the overall impact of the consultant contract.

We do not have information on the up-to-date position, but you are right that the consultant contract report that we produced earlier this year highlighted problems for the Western Isles in filling its vacancies and meeting the cost of implementing the contract. We have not gone back to match those findings against what the auditor said about the cost of locums, but the position is completely consistent with what we found earlier.

We have all seen press reports about locums, particularly about general practitioners in the Western Isles, and the alleged amount of money that they cost the service. Is the cost of locums the only problem that has led to the board's current financial position or are there other issues?

The cost of locums is a contributory issue, but it is not the only issue.

As there are no further questions on the section 22 reports, I thank the Auditor General and his team for that briefing. Members will discuss our reaction and what action we might take under item 8.

Before we move to item 7 on the review of community planning partnerships, I suspend the meeting for five minutes to let our clerks organise us and our guests at the table.

Meeting suspended.

On resuming—